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Rental Property CPA discusses Short Sales and Foreclosures Gain or Loss | tax Form 8825 and Schedule E

Rental property CPAs still see Recession related short sales and foreclosures with their tax Form 8825 and Schedule E clients. Here are some topics I field the most questions on:

  • Rental property profit or loss for the last year. Note that both Form 8825 and Schedule E loss is different from the loss from the “sale” of the rental property.
  • Debt cancellation issues from tax form 1099-C.
  • Calculating gain or loss on the “sale” of the rental property.

Final tax form 8825 or Schedule E

This is straight forward. When financial problems cause a short sale or foreclosure, the rental property usually generates a loss in the last year. You’ll need to pro rate the depreciation for the last year on Form 8825 or Schedule E, and then recapture it for the gain or loss for the “sale” (please read below).

Debt Cancellation via tax Form 1099-C

A rental property short sale or foreclosure doesn’t automatically mean the bank gives up trying to collect the mortgage balance.

  • The IRS requires the bank to issue tax form 1099-A upon foreclosure. This just reports the transfer of ownership to the bank along with a “Fair Market Value” of the rental property and the mortgage’s balance.
  • If and when the bank “forgives” the mortgage balance, the IRS requires the bank to issue a tax form 1099-C.
  • Sometimes Form 1099-A and Form 1099-C get issued simultaneously. Sometimes they skip issuing a Form 1099-A.
  • If you receive a Form 1099-A, expect a future Form 1099-C. Sometimes I’ll pull the IRS records to check if a Form 1099-C was issued. Why? It’s often sent to an old address.
  • The amount of debt cancellation on tax Form 1099-C becomes taxable income to the person, Partnership, Corporation or LLC. Yikes!
  • Your rental property CPA uses tax Form 982 to exclude cancelled debt from taxable income.
  • Form 982 impacts the rental property’s gain or loss from the “sale” via the tax attribute section.

Gain or Loss issues from the Short Sale or Foreclosure

I’ll ignore the impact other of other depreciating assets like appliances, even though most rental property sales include other depreciating assets besides the structure. Let’s ignore the financial impact of the land, if any, as well.

  • Your rental property short sale or foreclosure requires you to calculate the gain or loss it generated, and report it to the IRS via tax Form 4797.
  • Gain or loss from the sale of rental property is ordinary income and not Capital Gains.
  • It may seem obvious that you incurred a loss. But depreciation recapture and the tax attributes section of Form 982 impact the gain or loss.
  • The selling price isn’t zero. Generally the sales price is the amount of cancelled debt on Form 1099-C, but IRS wrinkles complicate it.
  • Purchase price. Your rental property CPA should check the original HUD statement. Sometimes I find buyer’s expenses that weren’t included in the purchase price.
  • Your depreciation expense from earlier years gets added back for the calculation of gain and loss. Note the last year’s depreciation gets claimed on Form 8825 or Schedule E. Then you add it back.
  • Prior excluded rental property loss. The special allowance of $25,000 passive loss rule phases out if your taxable income exceeds the IRS taxable income threshold. But upon the rental property short sale or foreclosure you can finally claim them.
  • The tax attributes section of tax Form 982. The amount of cancelled debt increases your basis calculation. This might seem unfair, but the IRS doesn’t want you excluding the cancelled debt and then double dipping on the sale.

I’m a rental property CPA because there’s rental property in my extended family. So I stay sharp on Form 8825 and Schedule E issues. Our virtual office allows us to offer service regardless of where the rental property is geographically located. (910) 399-2705.

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